The present invention relates generally to methods and apparatuses for trading securities or other instruments on behalf of investors, and more particularly to a method for trading securities on behalf of investors, in which trades are made as part of an investment portfolio.
Traditional full-service and online brokerages accept orders to purchase a particular number of shares of a security. The brokerages then execute those orders through a market maker in that security. These orders may take one of a variety of forms. The basic forms include: (a) market orders, in which the customer orders the brokerage to buy or sell a specified number of shares at the best price currently available in the market; and (b) limit orders, in which the customer orders the brokerage to buy or sell a specified number of shares at or better than a specified price. The orders are then relayed to market makers for execution in essentially the same form that they are presented to the brokerages by the customers. That is, the brokerages frequently do little more than pass the order on to the market maker for execution.
There are several limitations to this traditional method of executing orders to trade securities. First, they are relatively inefficient from a transaction cost perspective. There are economies of scale to be gained by combining the orders and presenting the market maker with one large order per stock, rather than hundreds or even thousands of small orders per stock.
Second, this method does not always secure the best execution for customers. For example, assume the bid-ask spread on a stock X is $1. If customer one, C1, wants to buy that stock from a brokerage using the traditional method, C1 will pay Pa (the ask price). If the brokerage has another customer, C2, who wants to sell the same stock at the same time, C2 will pay Pb (the bid price)=Pa−$1. If the brokerage were to combine the orders, however, it could execute the trade at a superior price from the perspective of both C1 and C2 by selling C2's stock to C1 at the mid-point price, Pm=(Pa+Pb)/2. This yields the buying customer a lower price and the selling customer a higher price than either would get under the traditional method.
Third, the traditional method requires investors to trade in share amounts, rather than dollar amounts. Normally, an investor places a market order by specifying a number of shares that the investor wishes to buy or sell and entrusting the brokerage to obtain the best execution within a short time-frame. The investor using a market order can approximate the dollar amount involved in the transaction only by multiplying the number of shares specified by the price at which the investor believes the trade will be executed. Typically, however, the investor has only a rough idea of what the execution price will be. The investor has a somewhat better idea of what the maximum or minimum dollar amount of a purchase or sale will be if the investor places a limit order. Even under a limit order, however, the investor will not know the dollar amount of the trade until the trade is executed. The investor also risks not having the order executed at once or at all, if the conditions of the limit order are not satisfied either at once or within the period in which the order is effective.
Many mutual funds permit investors to express orders in dollar amounts or in share amounts. This practice, however, also suffers from several limitations. First, mutual funds do not combine the orders for execution on an open market. Rather, mutual funds combine orders to determine net cash flow into or out of the fund. Mutual funds then either invest the cash inflow or sell assets to raise money to cover the cash outflow. Second, mutual funds are generally priced at the end of the day and offer the same price per share to sellers and buyers (although the mutual fund may adjust the price to either to reflect either a back-end or front-end load). Hence, mutual funds do not have a method for equitably allocating a spread between a bid price and an ask price of a security among customers.
Accordingly, there is a need in the art for removing inefficiencies in the trading of securities or other tradable instruments representing underlying assets and liabilities, while adding more certainty to the trader as to the amount of the transaction prior to execution or even submission to the brokerage.